Lessons Learned & Miners Burned
With the Ethereum merge complete, the network has successfully graduated to a new stage in its development. So, now that the hype has died down and the camera crews have gone home, it’s time to talk about what we can tangibly take away from this event.
First, let us get the basics out of the way. When blockchain enthusiasts talk about the merge, they are probably talking about The Merge, referring to the transition of the main Ethereum network (helpfully called Mainnet) from a proof-of-work system to a proof-of-stake system. This happened on September 15th, 2022 with block 15537393.
What does this mean? Well, technically it means that the network does not reach consensus using blockchain miners anymore. Rather than miners racing to solve challenging problems in search of a reward to secure the chain, in proof-of-stake validators put their own ETH up as collateral and more casually confirm the state of the chain (in exchange for a reward of course). If these stakers act in bad faith, they can say goodbye to their collateral.
Okay, so why did Ethereum do this? Ultimately this was an environmental decision. Proof-of-work networks trade energy consumption in exchange for security. By switching to a staking system, Ethereum reduced its energy consumption by over 95%. The hope here is to make the network greener, hopefully attracting users who were otherwise concerned with the massive environmental impacts of proof-of-work systems (like Bitcoin).
Speaking of, let’s dive into our takeaways.
1. It pays to be flexible in life and apparently blockchain.
Ethereum mining was a profitable business until it wasn’t. At all. Up until the merge, mining on the blockchain generated billions in revenue every single month. The peak was November 2021 when $1.77 billion in revenue was mined compared to just over $167 million resulting from staking activity. Sure, figures varied widely based on the volatility of ETH prices, but that doesn’t take away from the fact that staking made up less than 1% of money made. However, overnight the merge made mining obsolete, as in you literally can’t do it anymore. Those organizations comfortable repurposing technology to the new staking world are figuring out ways to stay in business. Those that can’t, have already shuttered. This is an astute reminder to anybody in the space that blockchain is an emerging technology that can change dramatically on very short notice.
2. You can short but you can’t hide.
Over the past year, crypto prices have taken a tumble across the board. There are a variety of reasons for this from surging inflation impacting consumer speculative dollars to a blowoff of technology-driven hype. Regardless, many who were initially bullish on the blockchain were quick to switch their tune ahead of the merge, positioning themselves in preparation for a potential system break. Ethereum funding rates, representative of the direct cost of holding bullish or bearish futures positions dropped to nearly -80bps ahead of the merge, its lowest level ever.
In dollar terms, that means that a trader shorting $1m of Ethereum, was willing to pay the exchange $8,000 every 8 hours continuously in perpetuity to maintain the position. That’s brutal. The result? Well, really nothing. The merge went off with no issue and prices were relatively stable. If anything the major takeaway here is that even by comparison to traditional financial markets, forecasting cryptocurrency prices is extremely challenging. With his stakes come high rewards…but sometimes the stakes are too high.
3. All roads [eventually] lead to Washington, DC.
Tens of thousands of people excitedly gathered around the globe to live stream the Ethereum’s merge on YouTube. One unexpected watcher? That would be the U.S. Securities and Exchange Commission. This reputable body is tasked with drafting and enforcing regulations regarding the sale, creation, and distribution of investment products. Unsurprisingly, when the SEC was established in 1934, many of its tools were not honed to work with blockchains or cryptocurrencies (can you imagine solving a BTC hash by hand?).
Until this point, ETH has not been considered an investment product by the U.S. government due to not passing what is known as the Howey test. However, now that individuals must put up their own capital to participate in staking and token-generation activities, it seems SEC Chairman Gary Gensler may have changed his mind… When asked about Ethereum’s merge he noted that it was “another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others.” Hmmm… Really the Ethereum community shouldn’t be overly surprised. Given the market value of ETH is well over $160 billion, it should be expected that governments will want to start trying to reign in bad actors in the space and potentially enact legislation over the computer system itself. What would that look like? Nobody knows, but don’t expect change anytime soon.
In finality, Ethereum’s merge simply marks a single step on the platform’s long journey toward broader adoption. Sure, it may seem crazy now, but with technological advancements occurring every year, is it so wild that in a decade blockchain technology could sit comfortably in the middle of our society? Here at Metcy, we don’t think so.
Still, one thing we do know is that Ethereum is no longer just an experiment watched by a small niche community. It is real and here to stay. Its task now is to prove to the world that the distributed computing system has a real purpose and the ability to fulfill it.
